Jim Collins has great ideas about how you build a great business. Collins is not interested in telling you how to build a good company....

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Jim Collins has great ideas about how you build a great business. Collins is not interested in telling you how to build a good company. In the very first line of his book, Good To Great (HarperCollins, 2001) he says, “Good is the enemy of great,” adding, “And that is one of the key reasons we have so little that becomes great.”

Collins’s book, which has sold more than one million copies in hardcover, examines how 10 big publicly-held companies made the transition from good to great. Collins explains this by comparing the paths of these 10 great companies to their competitors–companies that he calls their “genetic twins.” He examines why $1 invested in Wells Fargo, for instance, in January 1973 grew to be worth $74.47 on January 1, 1998, while $1 invested in Bank of America over the same period grew to only $15.60.

A former professor at Stanford University’s Graduate School of Business, Collins and his team of grad-student researchers studied Abbot versus Upjohn, Circuit City versus Silo, Fannie Mae versus Great Western, Kimberly-Clark versus Scott Paper, Kroger versus A&P, Nucor versus Bethlehem Steel, Philip Morris versus R.J. Reynolds, Pitney Bowes versus Addressograph, Walgreens versus Eckerd, as well as Wells Fargo versus Bank of America. He traces the stories of these matched pairs and examines the common factors that differentiated the 10 great companies from their peers that did not achieve greatness. Collins now runs his own Boulder, Colorado consulting firm.

What are the differences between good and great companies? We’ve done 15 years of research on that question. You need four things to qualify as a great company. Number one, you have to have great performance relative to other investments. An investment in a great company must have outperformed the general market by at least 300% over 15 years. Number two, you must have made a unique, indelible imprint on the world you touch–an impact no one else could make as well or as distinctively. Number three, in the world that you touch, you must be regarded for your creative contribution or the way you carried yourself. And, finally, Number four, you must have longevity. You have to have done all of the above for at least 15 years. So the outputs of a great company are performance, impact, reputation, and longevity. But all this is not what it takes to become great. It’s just the definition of great.

Your research focuses on what makes a big company great. Do your ideas work for the small businesses our readers work in? The definition of a great company or a great organization applies to any size and any type. There is a building in my town of Boulder, Colorado, that achieves all of the outputs of a great company. It has spectacular performance, an impact unlike any other building in town, a reputation as the nicest space in which to do creative work, and it is 100 years old. A single operator owns this one building, but he’s got a great business.

The criteria can apply to big, small, or massive companies. In fact, I think it is easier to be great when you are small. Go back to the definition of great, which is great performance, a unique impact on the world that you touch, an excellent reputation, and longevity. When you are smaller, you are able to focus on those things. You don’t dilute them. You can have high performance as a small organization because you don’t have as much junk that you carry by being big. Your impact can be totally unique.

Moreover, it is easier to maintain your reputation in the world that you touch because you have fewer people. By having fewer people, you run fewer risks of those people diluting your reputation. Finally, with regard to longevity, as a company becomes big, it becomes harder to hang on to these variables. As a small company, you can really hone them with a lot of attention. In my own business, I deliberately am small. We will not grow beyond a certain size because I think that becoming larger would get in the way of doing great work.

One of the big ideas I took from your research about great companies is how important people are. Can you cover this? What being great is about is that however many seats you have on your bus, every single seat has to be filled with somebody that you have 100% confidence in, confidence that they are the right person to be on your bus. You must be sure that you can totally trust each person on your bus, and that they are driven to always do the best work that they can. You must know that each of them will take on extra responsibility because that is the kind of people they are. They understand that they don’t have a job. They have big responsibilities rather than a job. And every seat–I don’t care whether it is an assistant or a partner or whether it is a technical person, if you are a small bus–must be filled with somebody you consider to be an outstanding person who you feel incredibly lucky to have. If you feel blessed by each person you have on the bus, then you are doing well.

Let’s get into your research. We examine companies that have proven themselves to be great. We vigorously compare them to companies that during the same period could have become great but did not. We systematically ask what was different. That’s the key to our work, the matched pair method.

That method is a common-sense approach but it’s a different way of looking at a business. Explain it. It’s like a genetic twin study. We take two operations that had virtually the same size, opportunities, resources, and so forth, and we systematically contrast them. We derive from that the differences that explain why some companies make that leap to a higher level versus those that do not. In fact, the single most important contribution from our work is not our findings, it’s our research method. It can be used in any systematic analysis for determining what makes a company, person, or product great versus one that is not.

Say you wanted to study Microsoft, for example. You would go back to the 1984-1985 time frame and find another company that also had a personal computer operating system that was a viable potential standard, and that could have become Microsoft but did not. So you’d find its genetic twin–a company with the same technology and opportunities. You then have two companies coming from the same point in history, that were the same size, and that had the same resources. Yet only one became Microsoft. The question, given that they were twins and ended up very differently, is what was the difference?

What are the common traits of the great companies? What’s critical is not what they shared in common, but what they shared in common that was different from the comparison companies. If you studied great companies, you will find that they all had buildings, but that is not very relevant because the comparison companies all had buildings, too. So we were not looking for commonalities alone. We were looking for systematic differences. In terms of the systematic differences and distinct commonalities, there are ten fundamental principles that separate great from good.

At the risk of sounding like David Letterman, please list the top 10 reasons a company becomes great. Number one, those who build greatness build it in a cumulative fashion. It’s like turning a heavy fly wheel, or like compounding interest. You don’t do it in one step. It’s a cumulative effect of one turn after another, building momentum. That creates greatness over time. Number two, the very first thing you do in building a great company is that you do not think about where to drive your ‘bus.’ You don’t focus on your direction or your strategy. The first thing to focus on is who should be on the bus, who should be off, and who should be in which seat. Then, you figure out where to drive. I call this principle, “First, who; then, what.” You first think about who should be on the bus, then you think about where to drive.

Now that is counterintuitive. Initially, it does seem to cut across the grain. Most people would say you must first figure out where to drive your bus and then figure out how to get people there. But we found that that is what the average companies do.

So the first thing that great companies do is find great people. Get the right people on the right bus and the right people in the right seat. Then, you start worrying about where to drive it.

Okay, please go on with Number three. Principle three is that leadership is really not a variable. What matters is what we call Level 5 leadership, rather than Level 4 leadership. Level 5 leaders are humbler than Level 4 leaders, but combine that humility with a ferocious will to do whatever it takes to make the company great. They will fire their brother or mother if they have to–if that is what’s best for the company.

But they also are humble. The company is not about them, and they don’t talk a lot of their accomplishments. They are not people who are really trying to prove to you that they are a great person. They are just trying to build a great company.

Give me an example. Two stand out. One is Darwin Smith of Kimberly-Clark, who is clearly one of the top 10 CEOs of all time. Almost nobody has heard of Darwin Smith, but he turned Kimberly-Clark from a mediocre paper-products company into a truly great corporation in consumer goods, and he did it without ever drawing attention to himself. It was never about him; it was really about the company. He had the ferocious will to sell all the paper mills, and throw all of the company’s resources into the consumer business, which was a very gutsy move that most CEOs lack the courage to do. At the end of his career, he said he was just trying to become qualified for the job and that is how he summed up his tenure. Not only did he qualify, he ended up as one of the great CEOs of all times.

Who was the other one? Katherine Graham of the Washington Post Company. She took The Washington Post from an average regional paper to a great world newspaper. Yet she never really took much credit for it herself, even though she was the real leader. Without her, Woodward and Bernstein probably could not have done the Watergate story. The paper probably would have not published the Pentagon Papers. She was a woman made of absolute iron and ferocious will and she willed the Post into a really great journalistic enterprise. But she did it in a way that never drew attention to herself. It was really always about the journalistic enterprise and the great reporters.

You say that charismatic leaders who dominate are actually not correlated with great companies. In fact, it is negatively correlated. You can be a charismatic leader and build a great company, but it is much harder. We used to think of leadership charisma as an asset. What our research shows–and research at Harvard and Stanford–is that charisma, from a standpoint of building an enduring great company, is a leadership liability. You think you would find charismatic leaders in great companies. But you actually find charismatic leaders in the non-great companies and more uncharismatic leaders in the great companies. Yes, you have Sam Walton in Wal-Mart who was clearly charismatic and built a great company. But he is the exception rather than the rule.

Does this apply to small businesses? A lot of advisory firm owners are run by dominant, charismatic bosses. I taught small business and entrepreneurship at Stanford Business School for seven years. In all my years of teaching there and in all the cases that I taught, we saw a range of different types of leaders who built small businesses into companies. I don’t see any reason to believe that this idea would not be equally applied to small businesses based upon that teaching. Charisma is a dangerous thing. It tends to suppress other people’s points of view because they tend to listen too much to what the charismatic leader says rather than the charismatic leader listening to what other people say. The problem with charisma is that it tends to attract people who want to follow. My own view is that the smaller the environment, the more dangerous the charisma is.

I guess that ties into another factor in greatness you identify–the need to examine brutal facts about your company. Having a charismatic leader may discourage criticism. That’s the fourth principle, having the discipline to confront the brutal facts. In a great company, the truth is heard no matter how ugly or dark or unpleasant. A great company creates an environment where everybody would pick up rocks and look at the ugly things underneath. It’s an environment where it’s people’s responsibility to hold up the rock and shove it under the nose of company leadership. Then you can say, “Look at the ugly things under this rock! We have to pay attention!” If you create an environment where the brutal facts are confronted, you’ll tend to make better decisions.

That ties into the fifth principle: People in great companies make their decisions based on understanding, not bravado. In understanding those three dimensions of what I call the “hedgehog concept,” you understand what you are passionate about and that you can’t build anything great without being passionate. You first have to understand what you are passionate about, and what you can do better than anybody else in the world. Even in a small business, you have to think about this. You might say that in my particular geography, I can deliver investment advice and investment perspective better than anyone else because I know them better. And you have to be able to answer the question, “What can I contribute better than anyone else?” That applies to businesses small and big.

So you have to ask yourself: What can I contribute? It’s more than that. You must ask yourself what you can potentially contribute better than anyone else in the world. The third aspect of the hedgehog principal is to understand your economic engine, to understand how your economics best work, and build your system consistent with those economics. The fifth principle means that you need to set your goals and your direction based on an understanding of what you are passionate about, what you can be best in the world at, and what drives your economic engine.

You call it the hedgehog concept because of the ancient Greek proverb about a fox knowing many things versus a hedgehog knowing just one thing? It was brought to us by an Englishman named Isaiah Berlin, who found it in an ancient Greek poem about a battle between a hedgehog and the fox. Even though the fox is a smarter creature that knows more things, the hedgehog wins because the hedgehog knows one big thing and tends to stick with it.

Elaborate on the hedgehog concept. Walgreens, for instance, which ended up beating the market 15 times over 25 years, was very passionate about pharmacies. They loved them. They understood they could be the best in the world at not just drug stores, but convenient drug stores. They knew that what would drive their economics is profit per customer-visit, rather than profit per customer, profit per store, profit per year, or profit for transaction. Profit per customer-visit was what they based their goals on. Once they understood where their passion was, what they could be the best in the world at, and what their metric was, then they were a hedgehog. They knew one big thing and they knew it very well. The fifth principle is to understand your hedgehog concept, and be right about it.

And the sixth principle? Once you understand your hedgehog concept, you must have a culture of discipline to stick to it. People get distracted by growth, steer into the wrong direction. A true hedgehog has the discipline to say, “No, we are not going to do things that are not in our hedgehog concept. We are going to push forward in the direction of the hedgehog and not stray from that. There might be lots of potential things we could do that would not fit into our hedgehog concept, but everything we do will somehow fit into the hedgehog.”

And the next guiding principle? Assuming you have the discipline, and that you start to build momentum with that flywheel, Number seven is building technology accelerators that can take your business to a whole different level. Think of the Roman legions. Their hedgehog concept was the way they did battle. They were the original hedgehogs about battalion fighting. But what was really powerful was that the Romans adopted new technologies that would tie into the battalion form of fighting, whether it was catapults or whatever. They were very quick to adopt those technologies and harness them to their hedgehog concept. You must have the discipline to tie new technology to your hedgehog concept.

A lot of businesses approach technology in the wrong way, don’t they? The real key is not adopting new technology, but adopting the technologies that aid your hedgehog concept. You should only focus on those technologies. So if a Web site doesn’t tie directly to your hedgehog concept and you don’t need one, you can ignore it.

But if you harness a Web site to your hedgehog concept and you say, “I understand why this particular technology really helps me do my hedgehog,” that is technology you want to focus on. For example, in our case, we have a Web site. It doesn’t sell anything. You can’t buy anything there by design, because our hedgehog is all about teaching and learning and research, and it is inconsistent with the idea of teaching, learning, and research to sell things and ideas. We teach ideas, we do not sell them.

So when we built our site, we were very conscious of building a teaching site. It is designed entirely for people to be able to learn more about our ideas and research. We are using the site as a technology accelerator of our hedgehog, which relates to learning and teaching about great companies.

Everything has to be goal-focused, right? Most people have goals without understanding. That’s one of the reasons they fail. They have goals but they are the wrong goals. They are not goals about what you are passionate about, or what you can be the best in the world at, or what drives your economic engine. I can have a goal to climb Mt. Everest next week. It would be a stupid goal, even though it would be a goal, because it is not in my hedgehog. Most goals are the wrong goals. Principle five is about having understanding. If you have understanding, your goals will naturally come to you.

You were up to Number eight. The principle here is that you want to be a clock-builder and not a time-teller. You do not want to be the time-teller on whom everything depends for the answers and whom everybody must ask for direction. Instead of telling the time, you build a clock that can tell the time over and over again. If you build a clock, that is a much more powerful contribution than telling the time. That is a key transition for many small businesspeople. They start out as time-tellers, but the goals shift from being time-tellers to building clocks. Here’s the test: If you got hit by a bus tomorrow, would your business still run, and run just as well, if you were not there? If the answer is no, you are not a clock-builder. You are still a time-teller.

What else is needed to be great? Principle Number nine is that those who build great companies embrace the genius of “and” rather than the tyranny of “or.” The genius of “and” is looking for ways to have your cake and eat it, too. So you don’t say, “Well, okay, the tradeoff is between great service or low cost.” The genius of “and” says, “We must find a way to do great service and low cost. We will learn how to have systematic quality to move fast. We will learn how to have personal humility and professional will. We will learn how to have an environment in which people have a lot of freedom and a lot of responsibility.” And this idea–the ultimate “and”–is that you are in business for reasons other than making money, and yet you make money. Great businesses are never in business just to make money. Great businesses are interested in making a contribution, in doing something larger or more enduring than just making money, and because of that they actually wind up making more money. The genius of the “and” is that you do all these seemingly contradictory things at the same time.

That ties into your notion that great companies have certain values. Yes, and it also ties into Number ten–that a great company builds itself on core values that don’t change. You stimulate change and progress, but keep those values fixed. People who build a great company are driven by strong core values that do not change, and at the same time they are constantly improving and changing themselves. They have that duality of values that don’t change and practices that do change.

For instance, I have a wonderful accountant. He is a small businessman who is outstanding. He does everything we touched upon here, has a four-person accounting firm, and I love him. He is a fantastic person; he is truly doing something great. What makes it a great practice? First, my accountant is values-driven. He will fire any client, no matter how lucrative, if they want to do anything that is at all questionable in terms of their accounting or their taxes. No matter how big the client, or how much money they have, or how important they are to the firm, he will fire them if that client even indicates that they would like to do something that is remotely shady. He is very concerned with the value of genuine relationships with people, but guided by core values at the same time.

His business is put together in a way that is constantly changing–always using new technology or going off to improve himself and his practice. So he really displays the duality of preserving core values but stimulating improvement and progress. Like many of your readers, he doesn’t have a big company, doesn’t want a big company, but perfectly exemplifies this characteristic.

Editor-at-Large Andrew Gluck, a veteran personal finance reporter, is president of Advisor Products Inc.(www.advisorproducts.com), which creates client newsletters and Web sites for advisors. Advisor Products may compete or do business with companies mentioned in this column. Gluck can be reached atagluck@advisorproducts.com.

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